In a capitalist system the financial sector is supposed to be the grease that makes the wheels of the economy move forward – not be the wheels. In their outstanding book 13 Bankers – The Wall Street Takeover and the Next Financial Meltdown, authors Simon Johnson and James Kwak elegantly describe the role of a financial system in a capitalist economy. “The core function of finance is financial intermediation – moving money from a place where it is not currently needed to a place where it is needed”.
Doesn’t it seem sometimes like the American economy is passenger trapped in the back seat of a car driven by a drunken banker? The economy clutches its seat anticipating the next crash, hoping it isn’t hurt too badly…or killed. Looking back we have endured no less than four major financial disasters caused by a banking system run amok. Let’s recount briefly:
In the 1980’s US banks bet the farm on Latin American oil economies whose serial mismanagement wiped out any value and the resulting capital destruction forced the banks to ask the US government to intervene. The GH Bush administration bailed-out the banks by exchanging the dud loans for Brady bonds which carried a US guarantee. Sound familiar?
In the 1990’s Congress increased the FDIC insurance limit to $100K and banks and S&Ls took that US guarantee and turned it into a leveraged bet on US real estate. The result? Another painful recession followed by a government bail-out, though artfully managed, by the Residential Trust Corporation.
In 2000 investment banks fanned the flames of the internet stock bubble which ended in tears for the public. The popping of the internet bubble planted the seed for the 2008 financial crisis because the American public moved away from stocks and embraced real estate as the one thing Wall Street couldn’t manipulate. Oh baby we they wrong.
In 2006 ridiculously low short term rates manipulated by the Fed created an insatiable thirst from investors for yield which combined with lax regulatory oversight bordering on fraud combined to create the mother of all residential real estate bubbles.
So how many times do we have to be hit over the head until we get it right? Stephen Roach the respected economist and former Chairman of Morgan Stanley Asia is keeping score as well. He said in a recent interview that by his count there have been eleven financial crises over the last thirty years, or put another way one every three years. And if you look back at the last ten years there have been two whoppers so whatever happened to the “one in a hundred year event” the quants talk about.